Pension funds – opportunities, risks and costs

Do not think about your age now! Because pension funds have nothing to do with your pension. Rather, it is a low-risk form of investment. You can find out everything you need to know here.

Those who follow the news come across the term “bonds” again and again. Sometimes there is talk of government bonds that the European Central Bank (ECB) buys, sometimes of companies that issue bonds to get fresh money.

This means loans that investors or private individuals give to companies or states – and receive interest in return. For you as an investor, these securities are exciting because you too can benefit from the interest by investing in bonds – that is, buying them.

The easiest way to do this is with a so-called pension fund. You can find out exactly what that is, how it works and why it initially has nothing to do with your old-age pension in our overview.

What is a pension fund?

To clarify what a pension fund is, you should first understand how a fund works – and what a pension is in this context.

Pension: Even if the name suggests, pensions in the case of investment have nothing to do with your earnings in old age. Pensions or bonds are just another word for something called Bonds.

Bonds or pensions are loans from private individuals and investors to companies or the state. If you buy a corporate bond, for example, you will receive a security. The company that issued the bond receives your money in return and pays you a fixed interest.

The advantage for the company: It does not have to get the loan from a bank, but gets it directly on the financial markets – much like when issuing shares. The difference to shares: As an investor, you will not become Co-owner of the company and, unlike the shareholders, will not share in the company’s profits through the dividend payment.

A government can also issue a bond. In this case one speaks of government bonds. You can also invest in these.

Fund: You can think of a fund as an art basket into which you deposit money. This money is then invested in stocks, commodities such as gold or in bonds.

In this case one speaks of one Pension fund. That means: Your money is lent to companies or states for an agreed period and you get an interest paid for it.

What is the return on bond funds?

The following generally applies to bonds: If you hold them until the end, you will receive a payment based on a fixed agreement Repayment rate.

But this is rather unrealistic, especially if you invest in pension funds. Because this fund invests the money in many bonds with different terms. In this case, the yield largely depends on the development of interest rates on the market – and ultimately also on the interest rate level specified by the European Central Bank (see below).

However, since interest rates have been at a low level for years, pension funds do not generate satisfactory returns in the medium term either. You should therefore consider how large the proportion of pension funds in your portfolio really needs to be. With stocks, equity funds or ETFs, you can spread your risk widely and earn a significantly higher return than with bonds.

What is the risk of investing in pension funds?

Pension funds are generally considered to be a very safe, stable form of money investment that does not require large price fluctuations. This is why many investors add a few shares in bond funds to their securities account in order to spread the risk of loss more widely. However, pension funds hardly generate any returns, which you should consider when making an investment (see above).

With bond funds, however, the following applies: not every bond in which a fund invests is equally low-risk. This is due to the so-called creditworthiness, i.e. the creditworthiness of a company or a state. This is checked regularly and independently by so-called rating agencies. Companies (and also states) that are financially well positioned and have little debt get a good grade.

Ratings are like school grades

The best possible grade is an “AAA”, the worst possible grade is a “D”. In addition, there are various grades, such as “Plus” or “Minus”.

Investments in bonds or pension funds from companies or countries with a rating of “BB +” or higher are strongly discouraged. Because these are considered very speculative: It is quite possible that a company will go bankrupt and will no longer be able to repay its obligations, i.e. the borrowed money. Then it is likely that you will lose your money.

Buy pension funds when interest rates rise or fall?

You should consider pension funds falling interest rates to buy. What sounds paradoxical at first follows the price logic of bonds: If interest rates fall at the banks, many investors try to get a better rate of interest – and buy “old” bonds from companies or states because they promise higher interest income than the bank. These old bonds are often also in pension funds. The result: the price of these bonds rises, and with it the value of the pension fund.

When interest rates rise, the phenomenon is reversed: because the bank has more interest, companies or states also have to promise more interest on their new bonds. At such a moment, investors are selling comparatively “old” bonds with lower interest rates in order to secure the new ones with higher interest rates. As long as interest rates are still at a low level, it is not worthwhile to invest in a pension fund (see above).

How do bond funds differ from bond ETFs?

Traditional pension funds are managed by a fund manager. This means that it decides on the composition of the bonds in which investments are made. It’s different with ETFs. ETFs are called passive. Because here a computer algorithm simulates an index. Mostly there is talk of a stock index, then one would be one Equity ETF speak.

But there is also Bond ETFs, also Bond ETFs called. In this case, the ETF replicates a bond index. A well-known index is the Bloomberg Barclays US Aggregate Bond Index, which tracks the performance of many US companies. By investing in an ETF on this index, you spread your risk very broadly.

The key advantage of a bond ETF over a traditional bond fund: The costs of investing in bond ETFs are usually lower, since you do not have to pay a manager to manage the fund (see below).

How much does it cost to invest in a pension fund?

There are different costs for you as an investor if you want to invest in a pension fund. The main ones are the following:

  • Deposit costs: Since you first have to open a depotBefore you invest in a bond fund or bond ETF, you should keep an eye on these fees. With many online providers and direct banks there are no costs for a deposit. With conventional branch banks and savings banks, a deposit can cost more than 20 euros a year.
  • Entry charge: This is the amount a fund company receives for launching a fund. The front-end load is up to three percent, but online brokers often grant a discount on it. You should pay attention to this, because a high front-end load can reduce your return considerably in the long run. Incidentally, the front-end load usually does not apply to bond ETFs, but they do Order fees which are generally significantly lower than the front-end load.
  • Administration fees: These are the costs that a fund company charges for offering a fund and a manager controlling this fund. These costs are often summarized in the total expense ratio (“TER” for short). This rate is usually much lower for bond ETFs.

How do I compare pension funds?

The best way to compare different pension funds is to use portals on the Internet. You should pay attention to the following criteria:

  • Issuer: The question here is which companies issue the bonds. Which sector do you work in? Where are you based? How long have you been active? The question also arises with government bonds which countries issue the bonds. The question of possible issuers is closely related to creditworthiness (see below).
  • Creditworthiness: The creditworthiness, i.e. the creditworthiness of the companies or states that issue bonds, is very important to that risk correctly assessed (see above). You’d better forego some returns than invest in speculative bonds.
  • Yield: The risk also depends on the return. Basically, the more return, the higher the risk of losing your money.
  • Costs: You should definitely keep an eye on the different costs. The “TER” is particularly important. Because these annual fees can almost completely melt an already low return.

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